The Canadian Federal Court heard oral arguments on August 4 and 5 in a lawsuit that challenges the law that implements the intergovernmental agreement1 between Canada and the U.S. relating to the Foreign Account Tax Compliance Act2. This author attended the hearing. Surprisingly, the court committed to rule on the plaintiffs' motion for summary trial by September 30, the date by which the first transfer of information from Canada to the U.S. is required under the IGA3.
Two dual Canadian-U.S. citizens commenced the lawsuit on August 11, 2014,4 in the Canadian Federal Court in Vancouver, British Columbia. The impending ruling could have profound effects on the application of FATCA in Canada as well as Canada's ability to implement the OECD's common reporting standard (CRS) for the automatic exchange of information.
The court's ruling on the motion will be the first time a court in an IGA partner jurisdiction has decided the domestic legality of IGA-implementing legislation, and all 115 IGA partner jurisdictions will be eagerly awaiting the outcome.
As part of its federal budget announcement, Canada committed to implementing the OECD's CRS starting in July 20175. The announcement reaffirmed Canada's commitment to introduce draft legislation in 2015. Since the reporting obligations and mechanics of exchanging this information are based largely on the architecture of FATCA and the IGAs, the court's ruling may therefore also affect Canada's ability to fully participate in the CRS.
If the court rules in favor of the plaintiffs, it won't be the first time Canada has invoked domestic law to depart from the rigid strictures of the IGA and FATCA to arrive at a domestically palatable solution. In 2014, Canada's newly enacted domestic legislation defined the term "financial institution" differently from the definition in the IGA, the FATCA regulations, and other IGA partners' domestic legislation. While Canada's definition was a departure from the letter of the IGA, it was consistent with the spirit of the agreement and, most importantly, accomplished the intended result for FATCA compliance in Canada6.
Motion for Summary Trial
In their motion, the plaintiffs are seeking an order that would "permanently enjoin the Minister of National Revenue from disclosing to the United States government... the private banking information of U.S. persons resident in Canada who are Canadian citizens or residents when such disclosure is contrary to the Canada-US treaty"7. In other words, if the plaintiffs are successful, Canada would be precluded from complying with the FATCA information exchange, at least insofar as the court holds that the information to be exchanged is outside the scope of the treaty.
While the plaintiffs' arguments in the 2014 pleadings primarily address Canadian constitutional law, the pleadings in the motion for summary trial largely reserve those arguments for the full trial, and instead focus on limits on the collection and exchange of information found in the Canada-U.S. treaty,8 the IGA, and Canadian domestic law.
At the hearing, the court acknowledged the short amount of time before its self-imposed deadline to rule. Consequentially, the court noted that the ruling will likely be in the form of a bare order, with the reasons for the order to follow. The impending ruling may take one of three forms. First, the court could hold that the exchange of information is within the scope of the treaty and refuse to enjoin the exchange. In that event, a full trial would likely follow on the reserved Canadian constitutional issues.
Second, the court could hold that the information to be exchanged is entirely beyond the scope of the treaty and Canadian domestic law and, therefore, enjoin the exchange of information planned for September 2015. In that event, the defendants would likely appeal the ruling. The appeal and the trial on the reserved constitutional issues would likely proceed later this year or next. Until the treaty and constitutional issues are finally resolved by the courts, Canadian financial institutions would likely be subject to the full weight of FATCA if, as a result of the ruling, the IGA is determined to be in force. To prevent this result, the U.S. Treasury or the competent authorities would likely intervene.
Third, the court could hold that the information scheduled to be exchanged is beyond that permitted under the treaty or Canadian domestic law and enjoin the exchange of the offending information. If the two individual plaintiffs' information is enjoined from the exchange, then the defendants would likely appeal the ruling, and the appeal and trial on the reserved Canadian constitutional issues would likely be heard later this year or early next year. It is unclear whether such a ruling would result in the IGA not entering into force. If so, however, the U.S. Treasury or the competent authorities would likely intervene to prevent this result.
Succinctly stated, and without the deft and nuanced analysis found in the pleadings,9 the plaintiffs argued that account holder information set to be exchanged under the IGA is more extensive than that which is permitted by Canadian domestic law and treaty articles XXVI-A (assistance in collection), XXVII (exchange of information), and XXV (non-discrimination). The plaintiffs summarized their position as follows:
It is the plaintiffs' position that only a tiny subset of the information collected by Canada from Canadian Financial Institutions might be disclosable and if the United States is made aware of the severe limitations on what Canada will disclose, it likely will not even care to have that information. This will simply demonstrate that Canada was caught by the U.S. FATCA worldwide net without any good reason10.
Taken at face value, the plaintiffs' position would greatly limit the exchange of information contemplated by FATCA, which (the defendants argued) could not reasonably be what Canada and the U.S. intended when they entered into the IGA. The defendants proffered the counterargument that under Canadian law, interpreting a tax treaty is different from interpreting a statute and that "[a] literal or legalistic interpretation should be avoided if it might defeat or frustrate the intentions of the parties"11.
Article XXVI-A: Assistance in Collection
The plaintiffs noted that Article XXVI-A:8 of the treaty precludes Canada from assisting the U.S. to collect taxes from individuals who were also Canadian citizens when the U.S. makes a revenue claim. They then argued that since providing account holder information includes everything needed for the IRS to assess and collect taxes, providing the information is equivalent to assisting the U.S. to collect taxes. In their notice of motion, the plaintiffs concluded, "Accordingly, this disclosure of accountholder information results in having provided assistance in the collection of Revenue Claims"12. In most cases, the argument that the disclosure of information is tantamount to assistance in collection falls a bit flat because the IRS's authority to assess tax and penalties is typically subject to the deficiency procedures found in sections 6211 through 6215 of the code. The deficiency procedures generally assure the taxpayer access to administrative review (namely IRS Appeals) and a prepayment judicial forum (namely the U.S. Tax Court) for reviewing disputed additions to tax and penalties proposed by the IRS13.
However, "assessable penalties"14 are ineligible for the procedural safeguards of the deficiency procedures and can be assessed almost immediately by the IRS. Neither party raised the issue of assessable penalties in their submissions, but doing so may have helped the plaintiffs' argument that disclosure of account holder information is the equivalent of providing assistance in collection.
Specifically, the failure-to-file penalties imposed by Chapter 61 of the code are assessable penalties ineligible for the deficiency procedures referred to above, and they may be assessed without affording the taxpayer access to administrative review and prepayment judicial forum. Further, the IRS may assess these penalties by simply providing the taxpayer with notice and demand for payment, and if payment is not made within 10 days, the IRS may commence collection15. This issue is even more important for U.S. citizens residing abroad because the failure-to-file penalties on many common information returns (for example, forms 5471,16 5472,17 926,18 8865,19 and 893820) are assessable penalties. Consequentially, merely providing account holder information could be tantamount to assisting in collection, at least as it relates to assessable penalties.
Article XXVII: Exchange of Information
The plaintiffs noted that Article XXVII:1 of the treaty requires the competent authorities to exchange "such information as may be relevant for carrying out the provisions of this Convention or of the domestic laws of the Contracting States concerning taxes to which this Convention applies insofar as the taxation thereunder is not contrary to this Convention" (emphasis added). Next, the plaintiffs presented several arguments that the account holder information to be exchanged is irrelevant to taxes covered by the convention.
First, the plaintiffs noted that a large majority of U.S. citizens resident in Canada do not owe taxes to the U.S. because of the treaty and the double-tax-mitigating provisions of U.S. domestic tax law (for example, the foreign tax credit, foreign earned income exclusion, and so forth). Accordingly, the plaintiffs argued that account holder information would be relevant only to the U.S. persons who, for various reasons, may owe U.S. taxes21.
On the first point, the defendants counterargued that the plaintiffs' position was unreasonable because it would require the Canada Revenue Agency to determine an affected individual's U.S. tax liability before exchanging account holder information on the taxpayer22. The defendants argued that "the CRA could not be expected to interpret and apply the different domestic tax laws of all 92 of its treaty partners. This interpretation of the Convention leads to absurd results"23.
Second, the plaintiffs noted that the information to be exchanged under Article XXVII is limited to taxes to which the treaty applies, and specifically to tax on income and capital. Further, the plaintiffs argued that the tax information reporting requirements of U.S. tax law (on which failure-to-file penalties may apply but for which no tax is calculated) are irrelevant to the tax on income and capital to which the treaty applies and are therefore not subject to the information-sharing provision of Article XXVII24.
On this second point, the defendants counterargued that account information is relevant under Article XXVII because it assists in the administration of U.S. tax laws by "encouraging, enforcing and verifying compliance with those laws by U.S. taxpayers"25. Further, the defendants noted that tax information reporting requirements are similar to those imposed by Canada that do not require information to indicate income or tax liability. In particular, the defendants argued that section 233.3 of the Canadian Income Tax Act requires Canadian taxpayers to report specified foreign property with a cost basis of more than $100,000, including capital held by foreign financial institutions. Further, the report required of Canadian residents by section 233.3 assists the Canadian government in the administration of its tax system, and therefore, a treaty request for information that may be relevant to the enforcement of section 233.3 would be permitted under Article XXVII26.
U.S. Sen. Rand Paul, R-Ky., has used the same "may be relevant" argument under Article XXVII of the U.S. model treaty to block the ratification of all new tax treaties. Paul's position is that the "may be relevant" provisions of Article XXVII violates U.S. taxpayers' Fourth Amendment privacy rights, a position not shared by Robert Stack, Treasury deputy assistant secretary. (Prior coverage.) Further, on July 14, Paul, along with six current and former U.S. c citizens living abroad, filed a lawsuit that challenges the constitutionality of FATCA and foreign bank account reporting. (Prior coverage.)
Third, the plaintiffs argued that not only does Article XXVII limit the information to be exchanged to that which may be relevant to the taxes covered by the treaty, but that it is not meant to apply to blanket disclosures of bank account information27. In support of this argument, the plaintiffs cited the U.S.'s technical explanation to the fifth treaty protocol,28 which provides:
However the language "may be relevant" would not support a request in which a Contracting State simply asked for information regarding all bank accounts maintained by residents of that Contracting State in the other Contracting State, or even all accounts maintained by its residents with respect to a particular bank29.
The plaintiffs then argued that FATCA and the IGA were designed to deliver the very thing that the technical explanation says Article XXVII precludes: the blanket exchange of bank account information. Further, they cited the OECD commentary on the model exchange of information agreement, which says that "the Contracting Parties are not at liberty to engage in fishing expeditions or request information that is unlikely to be relevant to the tax affairs of a given taxpayer." Admittedly this is a very strong argument, and the clear language of the technical explanation is difficult to rebut. However, the defendants offered two counterarguments.
First, the defendants' expert witness, professor John Steines of New York University, noted in his affidavit that a close reading of the technical explanation might not have the same meaning that the plaintiffs attribute to it. In particular, Steines stated:
I note that the requests made by the United States regarding dual citizens residing in Canada are not the subject of the quoted language, which, in contrast, refers to requests made by the United States to Canada regarding U.S. residents30.
In other words, although the technical explanation refers to blanket exchanges of account information, the syntax of the quoted language doesn't support the plaintiffs' position. Specifically, the technical explanation references one state (for example, the U.S.) requesting bank account information from the other state (for example, Canada) on its residents (for example, residents of the U.S.) with financial accounts in the other state (for example, Canada). Since the plaintiffs are not U.S. residents, the quoted technical explanation wouldn't preclude the exchange of their account information.
Second, the defendants noted that the technical explanation is not binding in interpreting the treaty31. Further, the technical explanation should be read in light of when it was written (2007), which was three years before FATCA became law in the U.S. Finally, since the exchange of information under the IGA is similar to the type of information excluded from being exchanged under the technical explanation, it would be unreasonable to interpret the treaty in a manner that excludes this type of information.
Article XXV: Non-Discrimination
The plaintiffs noted that under Article XXV of the treaty, Canada is precluded from subjecting U.S. nationals resident in Canada to taxation or other requirements that are more burdensome than the taxation and connected requirements to which Canadian nationals resident in Canada are or may be subject32. The plaintiffs then argued that the Canadian implementing legislation requires the CRA to deliver to the IRS account holder information for U.S. nationals, but Canadian nationals are not subject to this requirement. In other words, "US persons are accordingly subject to a burden to which other Canadians are not: the burden of having their financial information turned over to a foreign government"33.
The defendants countered that the plaintiffs' reliance on Article XXV is misplaced for three reasons34. First, the IGA and Canadian domestic law do not impose more burdensome requirements on U.S. nationals because the obligations imposed under those bodies apply to financial institutions and not to the U.S. nationals themselves.
Second, the direct burden of disclosing banking information on the plaintiffs is imposed by U.S. law, and only indirectly by Canadian law. Third, U.S. nationals resident in Canada are exposed to the same burdens as are Canadian nationals with U.S. indicia or who are U.S. persons35. Thus, the defendants argued, Article XXV does not preclude the exchange of information.
Counsel for both the plaintiffs and defendants have made compelling arguments to support their positions and to rebut their opponents' positions. Given the complexity of FATCA and international law, their efforts are impressive. More impressive than counsels' efforts, however, is the commitment of the court to render its decision on these frightfully complex issues on such a tight time frame. Given the stakes to the individual plaintiffs and the potential effect of the ruling on FATCA in Canada (and all IGA partner jurisdictions) and CRS, many practitioners anxiously await the court's decision.
1. "Agreement Between the Government of the United States of America and the Government of Canada to Improve International Tax Compliance through Enhanced Exchange of Information under the Convention Between the United States of America and Canada with Respect to Taxes on Income and Capital,"Feb. 5, 2014, U.S.-Canada.
2. Hiring Incentives to Restore Employment Act, P.L. 111-147, section 501 (Mar. 18, 2010), codified in sections 1471-1474 of the Internal Revenue Code of 1986, as amended (herein referred to as "the code" or "IRC").
3. The court noted that there was an agreement between the parties that Canada would not provide information before Sept. 15, 2015, but that the IGA required information to be provided by Canada on or before Sept. 30, 2015. Justice Martineau indicated that he would seek to publish a decision on the matter before any exchange of information takes place, but in his final comments noted that he would seek to issue a decision before Sept. 30, 2015. He may have misspoken and meant Sept. 15, 2015.
4. Virginia Hillis and Gwendolyn Louise Deegan v. The Attorney General of Canada and The Minister of National Revenue, Court File No.: T-1736-14.
5. The relevant portion of the budget announcement provides as follows:
Canada proposes to implement the common reporting standard starting on July 1, 2017, allowing a first exchange of information in 2018. As of the implementation date, financial institutions will be expected to have procedures in place to identify accounts held by residents of any country other than Canada and to report the required information to the Canada Revenue Agency. As the Canada Revenue Agency formalizes exchange arrangements with other jurisdictions, having been satisfied that each jurisdiction has appropriate capacity and safeguards in place, the information will begin to be exchanged on a reciprocal, bilateral basis. Draft legislative proposals will be released for comments in the coming months.
See http://www.budget.gc.ca/2015/docs/plan/toc-tdm-eng.html (last visited Aug. 11, 2015).
6. See Roy A. Berg and Paul M. Barba, "FATCA in Canada: Analyzing the Canadian Implementing Legislation's Restriction on the Class of Entities Subject to FATCA," 62:3 Canadian Tax Journal 587 (2014), available at http://www.ctf.ca/CTFWEB/EN/Publications/CTJ_Contents/2014CTJ3.aspx.
7. Memorandum of Fact and Law of the Plaintiffs, dated May 8, 2015, at para. 5.
8. "Convention between the United States of America and Canada with Respect to Taxes on Income and on Capital," Sept. 26, 1980, as amended by protocols on June 14, 1883, Mar. 28, 1984, Mar. 17, 1995, July 29, 1997, and Sept. 21, 2007 ("treaty").
9. Both the plaintiffs and the defendants made a variety of creative, elaborate, insightful, and adroit arguments in their submissions to the court. In this article, I do not attempt to address all of the arguments made. Instead, I have attempted to summarize the main points of the primary arguments and provide commentary where it might be helpful.
10. Supra note 7, at para. 49.
11. Motion of Record of the Defendants (Volume 1), dated July 13, 2015, at para. 54.
12. Supra note 7, at para. 61.
13. See American Bar Association Section of Taxation, "Statement of Policy Favoring Reform of Federal Civil Tax Penalties," Apr. 21, 2009.
14. IRC section 6679(b).
15. IRC sections 6155 and 6331.
16. "Information Return of U.S. Persons With Respect To Certain Foreign Corporations." Per IRC section 6038(b) the penalty for failure to file is $10,000 and reduction of foreign tax credits.
17. "Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business." Per IRC section 6038A the penalty for failure to file is $10,000.
18. "Return by a U.S. Transferor of Property to a Foreign Corporation." Per IRC section 6038B the penalty for failure to file is 10 percent of the value transferred with a maximum of $100,000.
19. "Return of U.S. Persons With Respect to Certain Foreign Partnerships." Per IRC section 6038B the penalty is $10,000 or 10 percent of the value transferred to the partnership with a maximum of $100,000.
20. "Statement of Specified Foreign Financial Assets." Per IRC section 6039D the general penalty is $10,000.
21. Supra note 7, at paras. 81-85.
22. Supra note 11, at paras. 80-92.
23. Id. at para. 87.
24. Reply Argument of the Plaintiffs, dated July 30, 2015, at para. 12.
25. Supplementary Motion of Record of the Defendants, dated July 30, 2015, at para. 5.
27. Supra note 7, at paras. 88-100.
28. Dept. of the Treasury, "Technical Explanation of the Protocol Done at Chelsea on Sept. 21, 2007, Amending the Convention Between the United States of America and Canada With Respect to Taxes on Income and on Capital Done at Washington on Sept. 26, 1980, as Amended by the Protocols Done on June 14, 1983, Mar. 28, 1994, Mar. 17, 1995, and July 29, 1997."
29. Supra note 7, at para. 90.
30. Motion Record for the Defendants (Volume I), Affidavit of John P. Steines, at footnote 68. Admittedly, the point is technical, which may be the reason it was relegated to a footnote in Steines's affidavit.
31. Supra note 11, at paras. 91-92.
32. Supra note 7, at paras. 101-104.
33. Id. note 7, at para. 102.
34. Supra note 11, at paras. 101-104.
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First published in Tax Notes International on August 24, 2015, pp. 635-639.
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